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September 16, 2010

Geithner’s Tough Talk on Chinese Yuan Disappoints

In testimony Thursday before the Senate Banking Committee, Treasury Secretary Timothy Geithner said the Obama administration will get tougher on China, suggesting that the United States' giant trading partner must do a better job in curbing its manipulation of the currency market.

"We share the concern of the Committee and many of your colleagues about China's exchange rate policy," Geithner said in his prepared remarks. "Clearly, China's exchange rate must play an important role in this effort. However, exchange rate appreciation also needs to be complemented with structural reforms to reduce the gap between saving and investment in China in order to bring about a durable rebalancing."

But Geithner fell short of announcing any specific action that the administration plans to take.

"I was surprised that it wasn't as aggressive as some in the market had believed that it might have been, and certainly not as aggressive as some politicians would have hoped for," said Kieran Osborne, a co-portfolio manager with Merk Investments of Palo Alto, California, a mutual fund company that specializes in currencies.

Geithner acknowledged the importance of the U.S.-China economic relationship, but added that the two countries must overcome trade-related challenges that have resulted in increasing distrust and acrimony on both sides. On June 19, the People's Bank of China announced plans for greater exchange rate flexibility along with the abolition of an artificial two-year peg to the dollar.

Since then, however, the Chinese government has limited the yuan's gain to less than 1% versus the dollar, which has angered U.S. politicians.

Geithner Proposes 'Three Core Objectives'

To address these challenges, Geithner proposed focusing on "three core objectives," which include: encouraging China to change its growth model to rely more on domestic demand and less on exports; moving toward a more market-determined Chinese exchange rate; and leveling the playing field for U.S. firms, workers, ranchers, farmers, and service providers to trade and compete with China.

Meanwhile, political pressure from both Republicans and Democrats is building on the Obama administration to take more forceful action against China's "currency manipulation"--a strong term that the administration has avoided using.

That didn't stop Senate Banking Committee Chairman Chris Dodd (D-CT) from using the term Wednesday at the hearing for the Treasury Department's report on international and exchange rate policies where Geithner spoke.

"Something as seemingly abstract as Chinese currency policy can mean a shuttered factory in Iowa," Dodd said in his prepared remarks. "For years, American workers have not been able to compete on a level playing field because of China's policies, and now they are struggling to secure jobs in the midst of a slow recovery from the global economic crisis."

Curbing Yuan's Rise Against Dollar Could Help Fight Inflation

Osborne, however, did agree with Geithner's argument that Chinese authorities should allow the yuan to appreciate because it would be good for the global markets as well as China itself.

"We've long argued that if China were to allow the currency to appreciate, it would combat some domestic inflationary pressures that they're experiencing domestically," Osborne said. "Chinese authorities are looking to implement a more flexible exchange rate over time. What will make them move is if it's in the best interest of China. They're unlikely to bow to Western pressures."

To be sure, the Obama administration faces a tricky situation, Osborne noted.

"They're very reticent to label China a currency manipulator," he said. The last thing you want to get involved in would be some sort of trade war or protectionism, which isn't good for anybody. Globally, it would create more inefficiencies and slow down growth. But they're also reliant on China to continue to buy all this debt that the Treasury continues to issue."

If the U.S. government doesn't resolve its issues with China, this country may see inflation exported out of China and onto the U.S. consumer, Osborne warned.

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